Treasury Risk Management – CAIIB BFM Part 3: Concepts, Questions & PDF Download

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📘 Conceptual Understanding and Detailed Explanation

1. RTGS Concept & Operation

Real Time Gross Settlement (RTGS) is the backbone of India’s high-value payment system. It enables instant, final, and irrevocable transfer of funds from one bank to another in real time.

Unlike NEFT or batch settlement systems, RTGS operates on a continuous processing mode, which makes liquidity planning critical. Treasury desks must maintain adequate funds with the RBI to honor outgoing payments without delays.

Example: If Bank A owes ₹100 crore to Bank B through RTGS, funds are transferred instantly. No netting or offsetting is allowed.

Exam Focus: How RTGS differs from NEFT, and its impact on liquidity management.

2. Intraday Liquidity Facility (ILF)

The Intraday Liquidity Facility is a temporary line of credit provided by RBI to banks during the business day to help them settle transactions without delay. This facility is collateralized using government securities from the bank’s SGL account.

At the end of the day, the facility must be squared off. Excessive or prolonged ILF usage indicates liquidity stress in a bank’s treasury operations.

Exam Angle: ILF vs Overnight Repo; settlement risk reduction through ILF.

3. RBI Repo Against Securities

A Repo (Repurchase Agreement) allows a bank to sell government securities to the RBI or another bank with an agreement to repurchase them at a later date, usually the next day. It’s an essential short-term borrowing tool.

The Repo Rate is the cost of borrowing for the bank, while the Reverse Repo Rate is the rate RBI pays when banks park funds with it.

Example: Bank A sells ₹100 crore in G-Secs to RBI today at 6.5% repo rate and buys them back tomorrow, paying interest accordingly.

4. Prefunding Clarification

Prefunding involves setting aside or transferring funds in advance to ensure sufficient liquidity for known obligations. In RTGS or large interbank settlements, prefunding ensures that payments are executed smoothly even if inflows are delayed.

This practice minimizes gridlocks and settlement failures but reduces the availability of deployable funds temporarily.

5. Interest Rate & Price Relationship

The fundamental principle of treasury management is the inverse relationship between interest rates and bond prices.

When interest rates rise, the present value of future cash flows declines, causing bond prices to fall — and vice versa.

Formula: ΔP/P ≈ –(Modified Duration × ΔY)

Example: If a bond with a 5-year modified duration faces a 1% increase in yield, its price will approximately decrease by 5%.

6. Volatility Concept

Volatility measures how much the price or yield of a financial instrument fluctuates over time. High volatility increases the uncertainty of returns and therefore increases risk exposure.

In treasury operations, volatility directly affects mark-to-market (MTM) valuation of securities and risk limits like VaR (Value at Risk).

7. Modified Duration

Modified Duration measures the sensitivity of a bond’s price to changes in interest rates. It refines the Macaulay Duration by accounting for yield levels.

Formula: Modified Duration = Macaulay Duration / (1 + YTM)

It estimates the percentage change in price for every 1% change in yield. A higher duration implies greater interest rate risk.

8. Yield to Maturity (YTM)

YTM is the internal rate of return earned by an investor who purchases a bond and holds it until maturity, assuming all coupon payments are reinvested at the same rate.

Example: If a ₹1000 bond offers 8% annual interest and is currently priced at ₹950, the YTM will be higher than 8% due to the discount.

YTM provides a comprehensive measure for comparing bonds with different coupons and maturities.

9. SLR Definition & Limit (40%)

Statutory Liquidity Ratio (SLR) refers to the percentage of a bank’s net demand and time liabilities (NDTL) that must be held in liquid assets — cash, gold, or government securities. As per RBI norms, the SLR limit is maintained around 40%.

SLR ensures liquidity stability and financial discipline within the banking system.

10. Liquidity & Credit Control

Liquidity control ensures that banks have sufficient funds to meet obligations, while credit control manages the flow of funds into the economy.

RBI uses multiple instruments such as CRR, SLR, Repo, Reverse Repo, OMO (Open Market Operations), and MSF (Marginal Standing Facility) to regulate liquidity and credit expansion.

11. Deal Confirmations & Settlements

Each treasury transaction must be confirmed between counterparties to avoid disputes. Settlement refers to the actual exchange of funds and securities, ideally on a T+1 or T+2 basis.

Errors or mismatches at this stage can lead to settlement risk, hence automation and reconciliation systems are crucial.

CAIIB BFM Treasury Risk Management Part 2 – Duration, SLR, NDS, Compliance, Bond Duration

12. RBI Guidelines for OBU Liabilities

Offshore Banking Units (OBUs) operate in Special Economic Zones (SEZs) and deal in foreign currency transactions. RBI regulates their liabilities, borrowing limits, and permissible activities.

Treasury departments must ensure OBUs comply with prudential exposure norms and maintain adequate capital against their offshore positions.

13. Accounting & Reconciliation

Every transaction in the treasury book is recorded based on accrual accounting principles. MTM (mark-to-market) adjustments are made for trading book assets, while the banking book follows amortized cost valuation.

Daily reconciliation ensures all securities, cash flows, and settlements match with the counterparty and clearing systems, thus eliminating operational risk.

14. Risk Management — Deal Size Limit

Deal Size Limits define the maximum exposure a bank can take in a single transaction or with a single counterparty. It prevents concentration of risk and aligns operations with the bank’s risk appetite and capital base.

These limits are part of the Treasury Risk Management Framework approved by the Board and monitored by the ALCO (Asset Liability Committee).

🧩 Practice Questions (Expected in Exam)

• What is the relationship between interest rates and bond prices? Explain with an example.
• Differentiate between RTGS and NEFT from a treasury risk perspective.
• How does the Intraday Liquidity Facility assist banks during settlement pressure?
• What is Modified Duration, and how is it different from Macaulay Duration?
• State RBI guidelines related to OBU liabilities and exposure management.
• Explain the importance of deal confirmations and reconciliation in treasury operations.
• What tools does RBI use to manage liquidity and credit in the economy?

📈 Preparation Strategy for CAIIB BFM Aspirants

Here’s how to make the most of this topic for your CAIIB BFM preparation:

• Watch the full CAIIB BFM Treasury Risk Management video lecture and make your own short notes.
• Revise all formulas – YTM, Modified Duration, Interest Rate Impact, and MTM adjustments.
• Download and print the PDF for offline revision.
• Practice case-based and numerical questions daily.
• Attempt mock tests and analyze performance for weak areas.

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💬 Final Words

Treasury Risk Management Part 3 blends both technical and analytical learning. Understanding market risk, liquidity dynamics, and RBI frameworks not only helps in CAIIB exams but also strengthens real-world treasury and risk management skills.

Keep revising, stay consistent, and you’ll master the art of treasury management effortlessly!